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Merrill Lynch agrees to settle SEC lawsuit for $131.8 million
by Joseph Earnest December 13, 2013
Newscast Media WASHINGTON—The Securities and Exchange Commission has charged Merrill Lynch with making faulty disclosures about collateral selection for two collateralized debt obligations (CDO) that it structured and marketed to investors, and maintaining inaccurate books and records for a third CDO. CDOs are the same as mortgage-backed securities or derivatives.
Merrill Lynch agreed to pay $131.8 million to settle the SEC's charges.
The SEC's order instituting settled administrative proceedings finds that Merrill Lynch failed to inform investors that hedge fund firm Magnetar Capital LLC had a third-party role and exercised significant influence over the selection of collateral for the CDOs entitled Octans I CDO Ltd. and Norma CDO I Ltd. Magnetar bought the equity in the CDOs and its interests were not necessarily aligned with those of other investors because it hedged its equity positions by shorting against the CDOs.
"Merrill Lynch marketed complex CDO investments using misleading materials that portrayed an independent process for collateral selection that was in the best interests of long-term debt investors,"said George S. Canellos, co-director of the SEC's Division of Enforcement. "Investors did not have the benefit of knowing that a prominent hedge fund firm with its own interests was heavily involved behind the scenes in selecting the underlying portfolios."
According to the SEC's order, Merrill Lynch engaged in the misconduct in 2006 and 2007, when its CDO group was a leading arranger of structured product CDOs. After four Merrill Lynch representatives met with a Magnetar representative in May 2006, an internal email explained the arrangement as "we pick mutually agreeable [collateral] managers to work with, Magnetar plays a significant role in the structure and composition of the portfolio ... and in return [Magnetar] retain[s] the equity class and we distribute the debt."
Click here to read or download SEC order. (pop-up)
The email noted they agreed in principle to do a series of deals with largely synthetic collateral and a short list of collateral managers. The equity piece of a CDO transaction is typically the hardest to sell and the greatest impediment to closing a CDO. Magnetar's willingness to buy the equity in a series of CDOs therefore gave the firm substantial leverage to influence portfolio composition. Add Comments>>
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